How to Stretch an IRA

Future generations can profit, but many beneficiaries take the money and run

If you're the person who is willed an IRA, here's what you need to do to make it stretch.

"When you inherit an IRA, the first rule is, touch nothing," says Slott. "If you roll the inherited IRA into your own IRA or even move it to another institution, the money instantly becomes taxable."

As the beneficiary, you must retitle the IRA with your name and the deceased's name. For example, "John Doe IRA (deceased Jan. 1, 2010) for the benefit of John Doe Jr., beneficiary."

You must begin withdrawals of the required minimum distribution (RMD) starting on Dec. 31 of the year after you inherit. They'll be taxable. Their amount is calculated by dividing the IRA's balance by the number of years of your life expectancy as determined by the IRS. The younger you are, the smaller the RMD.

If you want to stretch the IRA to a third generation and potentially make the account bigger, take out only the RMDs and try to invest the remaining principal wisely. As Slott puts it, you have to decide if you want the IRA to grow: "Do you want a little twig or a big tree?" he says.

Not all IRAs stretch

But not every stretch IRA is destined to become a tree. Reyes says that conditions that determine an account's continued growth may change. For example, IRS rules may evolve, returns on principal may vary, or a beneficiary may take out more than the minimum.

"Nine out of 10 beneficiaries want to take the money and run," says Reyes, so "stretching" never gets started.

A stretch IRA "looks good on paper," he says, "but too often doesn't translate into reality."